Holding the Invisible Hand

1. Holding the Invisible Hand Government Intervention in the Microeconomy

2. Central Questions of Government Intervention • Under what circumstances do markets fail? • How can government intervention help? • How much government intervention is desirable?

3. Market Failure • Optimal Mix of Output • Definition: • Nature of Market Failure • Definition of market failure: • Market Failure implies that the forces of supply and demand have not led us to the optimal mix of output • Sources of Market Failure • Public Goods • Externalities • Market Power • Inequity

4. Public Goods • Definition of Public Good: • Definition of Private Good: • Market Mechanism only works efficiently if the benefits of consuming a good or service are available only to those who purchase the product • Joint Consumption • One person consuming a public good does not preclude another person consuming the same good • “Free-Rider” Dilemma • Definition of “free-rider”: • Exclusion • In many cases, the technical capability to exclude “free-riders” from consuming a public good does not exist • Underproduction • The market tends to overproduce private goods and under produce public goods

5. Externalities • Definition: • The market will underproduce goods that yield external benefits and overproduce goods that generate external costs • External Costs vs. External Benefits • Social Costs vs. Private Costs

6. Market Power & Inequity • Market Power • Definition of market power: • The market mechanism functions through communications between producers and consumers by way of prices and purchases • The more market power a firm has, the greater its ability to ignore the desires of consumers and pursue profit maximization • Inequity • Market mechanism involves inherently unequal outcomes • Society generally expresses a desire for less unequal (but still unequal) distributions of wealth • Definition of income transfer • Table 9.1, pg. 205